The phrase credit crunch is being used again by the media to describe the freeze in lending that can occur at the tipping point of economic bubbles. This is however misleading, because it perpetuates the myth that “credit” is somehow fundamentally different from money. Using this phrase allows the public to carry on believing the false notion that there is an essentially fixed pool of money out there and the only problem is the banks willingness to lend it out. The truth is, credit is money. Due to the magic of fractional reserve banking, virtually every pound we spend is money that has been lent into existence. This is true even if we have no borrowings ourselves. During a so called credit crunch, there is an aggregate preference for paying back loans over taking out new ones. This shrinks the amount of money in the economy. The opposite of lending money into existence occurs, that is to say we have paying back money out of existence. The fraction of people, or even politicians, that are aware of this fact, is frighteningly small.
A shrinking money supply has a host of unpleasant side effects, as anyone who lived through the great depression would testify. During the period 1929–1933 the money supply fell by a third.
While we’re on the subject of misleading journalistic headlines, I’d also like to take issue with the use of the phrase “printing money”. The media and economic commentators have been telling us that governments around the world are currently “printing money”. This is misleading because it gives the impression that all that is going on is the money supply being permanently added to, and with no affect on debt. Most governments (certainly the US and all countries in the EU) are in fact legally barred from simply “printing money”. When our governments want to create more money, they have to do it via a circuitous route which effectively amounts to borrowing it from our central banks at the market rate of interest. So when the UK government want to add £100billion to the money supply, the Bank of England will create that money out of thin air and lend it to the government. This increases our national debt. The government is then obliged to pay the money back to its central bank where it will disappear back from whence it came, thereby reducing the money supply at some point in the future.
If only governments did truly “print money” debt free. It would help fend off the second great depression which we are just beginning.